The Conservatives called the debate after it emerged that property developer David Abrahams had donated more than £650,000 under four other peoples' names.

'Not obscure rule'

Gordon Brown has pledged to pay back the money which he said was not "lawfully declared". By law, anyone donating more than £5,000 must be identified and their details disclosed.

Mr Maude told MPs: "This has been a sorry tale of lawbreaking at the highest levels by one of Britain's biggest parties."

He said it was "literally incredible" that Labour former general secretary Peter Watt, who quit over the donations, or chief fundraiser Jon Mendelsohn had not known the practice of proxy donations was illegal.

The requirement to disclose the identity of donors was the "central feature" of the laws on party funding, he said, not "some obscure rule".

"The breach of this requirement is a criminal offence and anyone involved in political fundraising knows this," he said.

But Labour MPs hit back with questions about whether Lord Ashcroft was fully domiciled in the UK for tax purposes and about the identities behind the Midlands Industrial Council - which has made sizeable donations to the Conservative Party.

And veteran Labour MP Dennis Skinner asked about donations made to the last Conservative government by fugitive tycoon Asil Nadir, demanding: "Who is on the moral high ground now?"

Mr Maude said things must be difficult for Labour when they were referring to "ancient history".

'Utterly astonishing'

Claim and counter claims about different sources of funding continued throughout rowdy Commons exchanges - the Lib Dems were also asked if they would be repaying a £2.4m donations from Michael Brown - who was later jailed for perjury.

But Mr Straw's admission that he did not know whether the £650,000 had yet left the Labour Party's accounts was criticised by the Tories and the Scottish National Party.

Rich donors are nothing but trouble for the parties

David HeathLib Dems

SNP MP Angus MacNeil, whose letter sparked the cash-for-honours police inquiry, said it was "utterly astonishing" adding: "How can Labour cooperate with a police inquiry if they don't even know where the money is?"

The prime minister has said he wants to press ahead quickly with party funding reform - previous cross-party talks collapsed over a failure to agree on a raft recommendations in a review by Sir Hayden Philips.

'Big donor' culture

Lib Dem justice spokesman David Heath told the Commons debate that caps on donations and expenditure were needed to "get us away from the culture of big donors".

"Rich donors are nothing but trouble for the parties. That is demonstrably true," he said.

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"It demeans the political process that so much effort is made to woo people with large amounts of money."

Justice Secretary Jack Straw told MPs a White Paper on funding reform was in preparation and would be published as soon as possible - to be followed by legislation soon after.

He said the government hoped to achieve consensus for the future "but in any event we need legislation".

He said "democracy does not come for free" and blamed the Tories for the breakdown of previous talks.

Conservative former chancellor Ken Clarke said the parties should reach an agreement along the lines recommended by Sir Hayden, but the key point was how trade union block grants to Labour should be treated.

The Tory motion which noted "with concern the corrosion of public trust in democracy following the recent succession of scandals" over the funding of the Labour Party was defeated by 341 votes to 160.

A government amendment which regretted "that a comprehensive reform package" on funding reform had not been achieved before because the Tories had walked out, was passed by 300 votes to 198.